Suppose a government is established in a country where none previously existed.

Question

Suppose a government is established in a country where none previously existed. The government spends 110, financed by borrowing, to provide public services. If autonomous consumption plus investment is 190 and the marginal propensity to consume MPC = 0.75, what are the equilibrium real GDP values before and after the government is established?
Note: Please round your answer to two decimal places

a) What is the equilibrium real GDP value before the government is established?

Y0=

b) What is the equilibrium real GDP value after the government is established?

Y1=

c) Now suppose the government expenditure was financed by imposing a net tax rate on income of t = 0.2, what equilibrium real GDP would result?

Y2=

d) What is the multiplier before the tax is imposed?

e) What is the multiplier after the tax is imposed?

Explanation / Answer

A) Before the government is formed, GDP=C+I=190 B) We can calculated the fiscal multiplier as F=1/(1-MPC). F=1/(1-0.75) F=1/0.25 F=4 So, the new GDP is GDP=190+4*110=630 C) The new multiplier is F=1/(1-MPC(1-t)) F=1/(1-0.75(1-0.2)) F=1/(1-0.75*.8) F=2.5 So, the new GDP is GDP=190+2.5*110=465 D) The multiplier before the tax was F=4 E) the multiplier after the tax was F=2.5

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